Combining the 2009 Global Economic Policy Forum with the Law Alumni Association’s Annual Fall Lecture resulted in a high-octane panel of alumni who have or had front-row seats to the recent financial crisis and, hopefully, the recovery. The four panelists were able to see the crisis from a variety of contexts: banking regulation (Sara Kelsey ’76, former general counsel of the Federal Deposit Insurance Corporation); insurance regulation (Eric Dinallo ’90, former New York State superintendent of insurance); and crisis management (Neil Barofsky ’95, special inspector general for the Troubled Asset Relief Program, and Kenneth Feinberg ’70, special master of executive compensation under TARP). The discussion focused on a three-part question: How did this happen? Where are we now? And are we doing the right things to prevent it from happening again?

From the vantage point of their former jobs, Kelsey, who retired from the FDIC in October 2008, and Dinallo, who left the New York State Insurance Department in May and is now the Henry Kaufman Visiting Professor of Finance at NYU Stern, focused less on Wall Street’s risky behavior than the lack of regulatory capabilities to stop it. Stuyvesant P. Comfort Professor of Law Geoffrey Miller, the forum’s co-chairman and moderator, asked Kelsey whether she thought the FDIC was equipped to deal with a crisis that “descended on the U.S. and the world like a Category 5 hurricane.” Her short answer: No. One significant problem, she explained, was that much of the banking function in the financial system had migrated away from banks into other entities over which banking regulators and examiners had no jurisdiction. Because they were investment banks, she pointed out, the likes of Bear Stearns and Lehman Brothers were completely free of the regulation applied to traditional banks and, as a result, let their balance sheets become dangerously overleveraged. “When the emergency hit, it was clear to us at the FDIC that we didn’t have the tools to successfully deal with the failure of one of those entities,” she said. “Ours only extended to [FDIC-insured] banks…the institutions that were failing were not FDIC-insured.”

Miller then asked Dinallo whether he thought New York State had done as much as it could in terms of reining in an insurance industry that, like Wall Street, was seeking every method it could find to enable growth without capital constraints. Dinallo made a similar point to Kelsey’s: the entities the state had the authority to oversee performed adequately during the crisis, and it was essentially those insurance operations that had slipped through regulatory loopholes and away from state oversight that had caused much of the damage. Case in point: the financial products group at insurance giant AIG, which used derivative securities such as credit default swaps to effectively issue insurance without having to maintain traditional and sufficient capital requirements. “Congress permitted Wall Street to…replicate [the insurance function] without regulation,” he argued. “So there was no ability for regulators to oversee those [businesses]. Very soon [thereafter], a market that had been measurable in the billions raced up to $63 trillion.” Traditional insurance “performed brilliantly” in the crisis, Dinallo said. It was “pseudo-insurance” that didn’t.

Much of the two-hour discussion also focused on the heretofore-unprecedented level of government intervention in the financial system, both in terms of the massive Toxic Asset Relief Program as well as in the controversial realm of regulation of executive compensation. Whether these efforts have had their intended effect on spurring a recovery is still in question, although Adjunct Professor Alan Rechtschaffen, the forum’s co-chairman and moderator, said in his introductory remarks: “The good news is that…some analysts are telling us that the low point of the recession has been reached, and [that] we’re leaving the rescue plan and entering the phase of recovery. But unemployment is [still] too high. Yesterday the [Federal Reserve] observed that economic activity has picked up and financial markets have stabilized. But household spending remains constrained by job losses, sluggish income growth, lower housing wealth, and tight credit.”

Referring to TARP, Miller opened with a joke, comparing the program to the theory of relativity: everybody has heard of it, but few actually know what it is. He asked Neil Barofsky how the public could rest easy that such vast sums of money—by some measures, in the trillions of dollars—were being used properly, and be assured that TARP itself didn’t become a black hole?

Barofksy responded that it was understandable to be confused by a program that has been morphing on a near-daily basis since the original announcement that $700 billion would be used to buy troubled loans that were clogging banks’ balance sheets. “You may have heard that this was the greatest transfer of wealth from Main Street to Wall Street of all time,” he said. “Because there were no conditions put on the money when it went out. Banks weren’t told that they had to lend. [There] were no [oversight] mechanisms in place.”

He then went on to criticize both the Bush and Obama Administrations for failing to require that TARP recipients report on how they were using the funds. “We can talk about the cost of TARP, [and] the moral hazard costs,” he said, “[but] there is a third cost: the credibility of the government itself, which is one of its most important and necessary assets in dealing with the crisis. People need to trust their government and have faith when asked to come up with hundreds of billions of dollars.”

While most corporate chieftains would undoubtedly be comforted by the fact that Kenneth Feinberg does not think the government should really be in the business of setting executive compensation at private companies, he made it clear that he felt quite differently about some of those on the government dole—including the likes of Citigroup, Bank of America, General Motors, and AIG. “When I started this job there were a few people who said, ‘You know, it’s not the government’s business to determine compensation for individuals in private banking institutions,’” he said. “But that criticism quickly dissipated when the argument was made that [while] there may be some constitutional reasons the government shouldn’t interfere, [when] the taxpayer [actually] owns companies, as a creditor they have every right to determine compensation until they are repaid.”

Of course, the thought on nearly everyone’s mind related to the bailout and reform is whether the response from Wall Street and the federal government has gone far enough to prevent such a catastrophic blow to our markets again. On this, the panel was mostly pessimistic, although it noted some slivers of progress. Kelsey, for example, observed that regulation was inching toward giving banking regulators oversight at the holding company level. Dinallo saw the possibility of meaningful reform of derivatives oversight. And Barofsky pointed out that the myth that the sky would fall if the government were more transparent about its rescue operations had already been proven incorrect, and that the imperative for secrecy was losing its rationale.

The panel was nearly unanimous, however, in its criticism of the performance of rating agencies in the lead-up to the crisis, and on the challenges facing constructive and lasting reform. Barofsky noted two critical errors: “The reliance on credit rating agencies and the assumption that there wouldn’t be an across-the-board decline in nationwide housing prices. [Those] had as much to do with [what happened] as anything.”

There was also no argument that there is still much work to be done if we are to avoid a repeat of what just happened. “Looking back at 2008 some aspects of what happened that seem so obvious now were so not obvious at the time,” said Miller. “Everyone knew the housing market bubble was there. It was obvious [that] there was lots and lots of credit out there. It was obvious that firms were leveraging up. It was obvious that financial firms were financing themselves increasingly with short-term rather than long-term debt. And it was obvious…that a shadow banking system was growing. Those weren’t secrets. And yet so many people missed the looming threat.”

Barofsky responded to that observation with a sober one of his own: “What has changed? What did we do in response to each of these problems? Have we addressed the problems in securitization and housing? Or are we reinflating that bubble? What have we done with the shadow market of asset-backed securities? We created a trillion-dollar term asset backed lending facility, or TALF. We took the broken asset-backed securities market that created so much of this mess and replicated it without any modification or additional regulation. What do all these regulations and actions that we’re taking turn on? The same incredibly and inherently conflicted rating agencies that have as much influence today as they did before, with really no meaningful reform. Will we be sitting here one or two years from now asking, ‘Why did we [take] all these actions without a balance of reform?’”